I received this blog from Smashwords today, detailing developments in the lawsuit between Amazon.com and the Hachette Book Group. The references to “I” below are to the blog’s author, Mark Coker, the founder of Smashwords. The links are his, as well.

The news is pertinent to my State of the Biz Series and of such importance, I’m reproducing it here:

“Amazon and Hachette Book Group are locked in an epic battle over the future of ebook publishing. The outcome of this dispute will have permanent ramifications for publishers and indie authors alike.

On one side you have Hachette, the fourth largest trade book publisher. Hachette earns over 1/3 of its US sales from ebooks. Hachette wants agency terms for its books. Hachette wants to control the list price of its books and earn 70% list from each sale. Smashwords announced agency terms with our retail partners in 2010.

On the other side is Amazon, a fierce opponent to agency pricing. Amazon wants the ability to discount books, and to enable greater discounting Amazon wants a larger percentage of the publisher’s pie. A story out Friday by Jeffrey Trachtenburg of the Wall Street Journal confirms Amazon is seeking to reduce the percentage paid to publishers. Amazon is seeking to weaken or abolish the agency model.

This is also the view of Andrew Albanese of Publishers Weekly, who in his March 16 story, Will the Agency Model Survive? speculated that the future of agency hangs in the balance. As Albanese writes in his piece, the timing of the Amazon/Hachette dispute is not coincidental.

One likely reason (for the current timing of the dispute) is that when the publishers’ 2012 consent decrees in the e-book price-fixing case begin to expire this fall, so too will Amazon’s ability to discount e-books. The parties don’t comment on specific negotiations (and neither Hachette or Amazon will comment directly on the current dispute or ongoing talks). But it is fair to say that Amazon officials likely see the current negotiations as their best chance to push for the end of agency pricing for e-books, and are apparently prepared to bring to bear all the pressure they can on publishers—whether on the Kindle side, or print. The question is, will the major publishers stick together to keep agency pricing for e-books?

The dispute is generating some spectacular fireworks. It’s also confirming the suspicions of Amazon’s worst critics. In an attempt to force Hachette to capitulate, Amazon is employing a shock and awe campaign of scorched earth retribution against Hachette. According to multiple press reports, Amazon has increased Hachette’s book prices to its customers then turned its automated merchandising algorithms into attack dogs that encourage customers to consider “similar items at a lower price“; Amazon is telling customers Hachette print books are out of stock; and is denying Hachette the ability to list preorders. For a company that prides itself in customer service, these are all customer-unfriendly moves. These actions also punish Hachette authors, who through no fault of their own will suffer reduced sales at Amazon.

For the last four years, indie ebook authors have endured similar iron-fisted policy enforcement and lost earnings with Amazon’s KDP price-matching, even when Amazon knew the out-of-sync ebook prices were not the author’s intention or fault. Amazon plays business like war. Overwhelming force pushes weak hands to surrender and comply.

In a letter written to Amazon by the Association of Author’s Representatives (AAR), a trade group representing literary agents, AAR likened Amazon’s tactics to hostage-taking and extortion.

Amazon defenders (and critics too) and will say business is business, and if you want to play in the Amazon sandbox – the world’s largest ebook store – you have to play by their rules. The Amazon defenders are correct. Amazon is under no obligation to carry Hachette’s books under the terms Hachette wants. Amazon is under no obligation to play nice.

The industry can cry until it’s blue in the face about how Amazon is ruthless and heavy-handed, and how other retailers are kinder and gentler. The truth of the argument doesn’t change the reality. Amazon does what it does because it can, because authors and publishers let them do it, and because it’s in Amazon’s nature to act this way. Lions eat wildebeest.

For its part, Hachette is sending letters to agents and authors asking for their patience and support. In their May 23 letter, Hachette wrote:

Please know that we are doing everything in our power to find a solution to this difficult situation, one that best serves our authors and their work, and that preserves our ability to survive and thrive as a strong and author-centric publishing company.

Amazon is playing a game of divide and conquer. Amazon knows if they weaken or cancel their agency agreement with Hachette that the other publishers will have less leverage to hold the line on agency. And whatever concessions Amazon gets, other retailers will want the same, further undermining the ability of publishers to control their prices or maintain their profits.

Amazon’s tactics hit Hachette in two places where it hurts:

Author confidence – The dispute will undermine literary agent and author confidence that Hachette can deliver books to Amazon. This will cause some agents and authors to think twice before selling upcoming projects to Hachette.

Profitability – Amazon knows that if they if they can make Hachette the first domino to fall in their anti-agency crusade, it’s more likely to force other publishers to abandon it as well. Once agency is eliminated, ebooks will become less profitable to publishers, which then marginalizes publishers by weakening their strategic power in the marketplace. With lower margins, publishers will have less flexibility to increase ebook royalty rates to authors at a time when their authors are clamoring for higher royalties. This would thereby compel more authors to self-publish directly with Amazon, which benefits Amazon.

Publishers deserve much of the blame for making their ebook margins such an appetizing target for Amazon. Amazon’s assault on their margins should come as no surprise. In 2012, Adam Lashinsky of Fortune Magazine wrote that a favorite Jeff Bezos aphorism is “Your margin is my opportunity.” Publishers have been complaining about Amazon for years yet still supplied them the books that created Amazon.

Publishers have been reporting healthy earnings in recent months, driven in large part by high-margin ebook sales. Publishers pay authors only 25% of net ebook proceeds, whereas indie authors earn 85-100% of net proceeds. In other words, publishers made themselves a target for a company whose very DNA is programmed to strip suppliers (publishers) of their margin.

From a PR perspective, Amazon can cast their move as taking from the greedy publishers to provide customers lower prices. But in the end, they’re really taking from authors.

Hachette faces a dilemma. They face the lose/lose decision of either giving that margin to Amazon, or choosing to kiss its Amazon relationship goodbye. It would be painful for publishers to say goodbye to Amazon. Amazon controls approximately 1/3 of the overall trade book market in the US, and up to 50-60% of the ebook market.

In 2010, publishers presented Amazon with a unified front by simultaneously demanding agency pricing terms. This forced Amazon to capitulate and accept agency pricing. It was a different world back then. Amazon’s nascent Kindle ebook business needed the books of big publishers. The bitter aftertaste has never left Amazon’s mouth.

The publishers viewed agency as a better model. The US DoJ viewed the united front as collusion.

In 2014, publishers are more disposable to Amazon than they once were, thanks in part to the rise of indie authorship, and thanks also to better business diversification. Amazon’s business is no longer as dependent upon books as it once was. They sell everything under the sun, from diapers to shoes to cloud services to groceries to media devices.

Books represent only one of hundreds of layers of icing on the cake of Amazon. Amazon can lose money on books while still operating a profitable business.

Pure-play book retailers – Kobo and Barnes & Noble for example, must earn money from book sales. Unlike Amazon, they don’t have the financial resources to sell books at a loss forever. Publishers must also earn money from book sales, otherwise they can’t keep the lights on.

If Amazon can abolish agency pricing it will have the power to put its largest pure-play book retailing competitors out of business. This will make the publishers even more dependent upon Amazon, which further weakens their power.

How can Hachette get out of this mess? None of its options are good. Amazon holds the strongest hand in this high-stakes poker match.

The boldest option is for Hachette to play the nuclear card: they can withdraw all their books from Amazon. Hachette could direct readers to more publisher-friendly platforms and stores. Hachette could also make a more concerted effort to develop new channels of distribution. Curiously, neither Hachette nor any other major NY publisher has ever attempted to sell their books in the Smashwords ebook store, despite the fact that Smashwords pays up to 80% list. Publisher insistence on DRM is one of several factors that has locked them into Amazon and locked them out of new outlets. Most of the publishers are also refusing to work with the new ebook subscription services, or have treated libraries as second-class citizens, even though these two channels provide yet another healthy counterbalance to a single retailer’s dominance.

It’s uncertain if Hachette or other publishers could survive if they abandon Amazon. Would authors and literary agents continue to support them if their books didn’t reach Amazon?

The window of opportunity for such a bold move is closing quickly. Within the next several years, ebooks as a percentage of the overall book market will increase as print declines. Within a few years, Amazon’s sales of indie-supplied ebooks will probably exceed sales of publisher-supplied books. This means the leverage publishers hold over Amazon will diminish each year.

The other alternative is for Hachette to capitulate to Amazon, which is akin to Hachette accepting a long term death sentence. Amazon views publishers as unnecessary intermediaries. Amazon works to disintermediate the intermediaries so it can control the relationship with the creators (authors) and the customers.

The other Big 5 publishers might do well to play their nuclear cards before it’s too late.

If the big publishers capitulate and abandon agency, the other retailers, in order to remain competitive, will be forced to abandon their agency agreements with the publishers as well, otherwise Amazon would have the ability to underprice them. And then the pure-play book retailers would fall.

Are Indie Authors Next in the Crosshairs?

The dispute with Hachette foreshadows what comes next for indie ebook authors at Amazon who have grown comfortable to KDP’s 70% royalty rates.

Think about my divide and conquer reference above. Indies are already divided and conquered at Amazon, but most don’t realize this. These indies all have direct-upload relationships with Amazon. They don’t have the collective bargaining power of a large publisher to advocate on their behalf. As the unfolding events indicate, it’s questionable if even a large publisher has leverage over Amazon.

If Hachette doesn’t have the power to maintain 70% earnings, how will million-copy-selling New York Times bestselling indie authors have any power when Amazon decides to put the squeeze on them? And how about the rest of the indie community which has even less leverage over Amazon?

How long until Amazon puts on the squeeze? The squeeze may already have started. In February, Amazon gutted the royalty rates they pay for audiobooks, as Laura Hazard Owen reported at GigaOm in her story, Amazon-owned Audible lowers royalty rates on self-published audiobooks. Previously, authors earned up to 90% list. Under the new terms, authors earn from 25% to 40% list. Amazon can do this because they dominate audiobooks.

At any time, Amazon could choose to eliminate the 70% royalty option at KDP. They could offer the same terms as their Audible division: 25% list if you’re non-exclusive, and 40% list if you’re exclusive.

If Amazon tightens the screws, indies will face the same painful decision Hachette now faces. Either swallow the bitter pill, or remove your books from Amazon.

Most indies would probably choose to accept lower royalties at Amazon under the logic that something is better than nothing. As individuals, indies have little leverage against Amazon.

Most vulnerable to any change in policy at Amazon are the indie authors who supply approximately 500,000 ebooks to Amazon’s KDP Select program.

Advice to Indie Authors: Four Steps to Improve your Independence

Is it really necessary that retailers and publishers should view one another as war-like adversaries, or as predator and prey? I don’t think so. At Smashwords, we serve our authors by serving our retailers. We help our retail partners efficiently receive, ingest and sell our authors’ books. By opening up new retail and library channels, we support our authors. We think our new channels help our retailers too, because each new channel we open is a reminder that exclusivity is bad for publishing. What leverage we do have we apply to negotiating fair and equitable agreements that are win/wins for our authors and retailers. We want our retail partners to profit from our books, because if they don’t profit it’s not a long-term sustainable relationship. We believe the 70/30 agency split provides retailers a fair profit. I’ve always believed that partnership and cooperation are preferable to war.

As an indie author, it’s important you understand that you’re the future of publishing. Your choices matter. Your decisions will shape not only your future but the future for all indies. Your decisions will shape how retailers treat you. Independence is earned – it’s not something you can take for granted. Here are four tips to preserve your independence:

Choose your partners carefully. In the Indie Author Manifesto I wrote that indie authors should seek business relationships marked by partnership, fairness, equity and mutually aligned interests.

Favor retail partners that support the agency model. Agency puts authors and publishers in control and frees retailers to compete against one another based on customer experience rather than cut-throat price wars. The agency model enables lower customer prices because more of the money goes to the author/publisher rather than the retailer.Indies have used agency to lower ebooks prices while publishers made the mistake of using agency to raise prices.Agency establishes a framework by which authors and retailers can work in partnership rather than as predator and prey.

Avoid exclusivity. Exclusivity makes you dependent upon a single retailer. Work for independence, the opposite of dependence. Diversify your income stream by distributing everywhere. Every retailer reaches new readers you otherwise won’t reach. Each retailer, and each store they operate in each country, represents its own unique micro-market of readers. It can take years to develop readership, so maintain a strong and steady course of uninterrupted full distribution. This is similar advice I gave gave in 2011 when I cautioned authors to steer clear of Amazon’s KDP Select option.

So there you have it from Smashwords, my friends. The four points above are good advice, which I follow. Note that this means you’ll have to have three different formats for each book—one for Amazon, one for Barnes and Noble, and one for Smashwords. I post my titles on Apple and Kobo via Smashwords, but if you have the technical expertise to post directly on Apple and Kobo (as yet, I don’t, so it’s easier and quicker for me to post on those sites via Smashwords), you’ll need special formats for each of those sites, too.

Bear in mind, too, that Smashwords has a vested interest in stirring up authors’ anxiety about Amazon—they are bitter rival competitors for the retailing of ebooks.

Like Big Media’s continued investment in Blockbusters (as a select few individuals define and choose such properties) to the neglect of everything else, Amazon’s strategy is horrible for authors. All authors.

Next:

State of the Biz: Publishing in 2014 and Beyond Part 6: Market Share Lisa Mason #SFWApro